Commonly used terminology in High frequency trading - all details

Updated on
Oct 05,2018 - 05:33:55 AM

Commonly used terminology in High frequency trading: High-frequency Trading (HFT) is subfield of Algorithmic Trading. By the advances in computer technology and creating of sophisticated applications HFT has become very popular and promising way of implementing short-term strategies. Although trading strategies are already being used in the market, HFT has opened new doors to use this technology in full extent. HFT is another type of trading method in turning market positions over very quickly by exploiting these advanced technologies with highly low latency rates. Since its birth, it has become very popular and its popularity has increased highly in worldwide...

Algorithm:

Algorithm is a computer program that involves a sequence of operations executed step by step to solve a problem. Algorithms are the powerful tools that enable the computers solve the recurrent problems using a pre-designed set of instructions. Algorithms are the backbones of the technical infrastructure used for carrying out High frequency trading and algo trading.

Flash Trading:

This is a controversial method of computer trading where the information about the orders of market participants is flashed to a section of traders typically HFT firms for a fraction of second before that is made available to the public. Thus, the HFT will get to know the market information a split second before the rest of the investors which is a kind of preferential treatment. This is not allowed in majority of the countries including India as it is biased towards a section of the traders enabling them unfairly exploit the market.

Colocation:

In the context of high frequency trading, colocation is the process that allows the HFT firms to place their computer systems in the same premises where a stock exchange’s servers are located. This allows the flash trading to happen. Usually the systems are connected with wire enabling the HFT systems to access information a split second before the rest. Exchanges charge certain amount of fee for this. In India BSE provides the fastest Co-location service with round trip network latency of less than 10 microseconds.

Latency:

Latency is the time gap from the moment when the signal is sent till it reached the recipient. In the context of high frequency trading where milliseconds mean million dollars, latency plays very key role in profit making. HFT firms having their computer systems collocated in the stock exchange premises enjoy the low latency as the time required for a signal to travel in the network is very low when the receiver is very close within the periphery. HFT firms invest a lot of amount in acquiring sophisticated hardware and software that enable them to trade with the lowest latency.

Latency arbitrage

When the HFT firms make profits by using the advantage of low latency in receiving the market information relating to buy, sell orders placed by other market participants that is known as latency arbitrage.

Liquidity rebates:

To attract order flow while incentivizing market participants to provide liquidity at the most competitive prices, many stock exchanges and other non-exchange markets have adopted a fee structure where they pay a per-share rebate to their members to encourage them to place resting liquidity-providing orders on their trading systems. If an execution occurs, the liquidity providing “maker” receives a rebate, and the “taker” that executes against that resting order pays a fee to the market. Most of HFT firms have specially designed trading strategies to earn most out of the liquidity rebates by engaging in the trading at high volume.

Matching Engine:

It is the computer system that matches the buying and selling orders in a stock exchange. It ensures the smooth functioning of the exchange. Matching engines are situated at exchange’s premises which is why the HFT firms try to install their systems as much as close to the exchange to gain the advantage of faster processing.